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"Pharma Bro" Martin Shkreli's Day of Reckoning

Federal investigators have arrested the former hedge fund manager for securities fraud.

Pharma Bro Martin Shkreli has been arrested for allegedly bilking tens of millions of dollars from his former biotech venture, Retrophin(NASDAQ:RTRX). The arrest is the latest development in one of this year's most distressing biotech stories: runaway price increases for formerly cheap medicine.

Image source: Martin Shkreli via Twitter.

Too close to the sunShkreli, a former hedge fund manager, started a firestorm this past summer when his latest biotech company, Turing Pharmaceuticals, swooped in and bought Daraprim, a decades-old drug used to fight parasitic infection, and promptly increased its price by 5,000%

A tidal wave of disapproval followed, including condemnations from presidential hopefuls, including Hillary Clinton, who outlined a plan shortly thereafter to rein in drug prices and keep Shkreli-style price hikes from happening in the future, and Donald Trump, who called Shkreli a "spoiled brat."

In response, Shkreli unleashed Twitter missives that smacked of arrogance and cold-heartedness, further fueling a media backlash that included nicknaming him "pharma bro."

Eventually, mounting pressure led to Shkreli announcing that Daraprim's price would be rolled back somewhat; however, Daraprim's price increase still remains virtually intact.

More recently, Shkreli has been leveraging his newly found infamy to tweet his stock picks, including his purchase of shares in KaloBios, a floundering company that appeared destined for bankruptcy.

Shkreli's position in that heavily shorted company (and his public tweets concerning it) caused a massive short squeeze and big losses for investors who had bet against the company's survival. Following Shkreli's investment, KaloBios bought an infection drug for Chagas and plans to boost its price significantly.

A long-standing disputeToday's arrest has nothing to do, however, with Daraprim or KaloBios, and everything to do with his long-standing battle with his former company, Retrophin.

In Oct. 2014, Retrophin's board forced Shkreli out the door for misuse of company funds, and in August, Retrophin filed a lawsuit against Shkreli's seeking to recover $65 million from Shkreli in damages, as well as every dollar he had been paid by Retrophin.

The company's claims against Shkreli include his passing off legal settlements with hedge fund investors as consulting agreements with Retrophin, effectively putting Retrophin on the hook for losses his hedge fund investors had suffered in the past.

Retrophin's lawsuit also claims that Shkreli's main purpose for founding the company wasn't to advance medicine but to reward investors who had lost money in his hedge fund with Retrophin stock.

Specifically, Retrophin alleges that those hedge fund investors lost $7 million on a bad investment Shkreli made in 2011 that left Shkreli's fund virtually bankrupt.

Facing potential lawsuits and a potential regulatory investigation, Shkreli began tapping Retrophin to appease disgruntled investors by entering into consulting and settlement agreements.

According to Retrophin, between Sept. 2013 and March 2014, Retrophin paid former hedge fund investors $400,000 in cash and 612,500 in company stock under false consulting agreements.

Between September 2013 and March 2014, the Company entered into several consulting agreements and releases with individuals or entities that had been investors in investment funds previously managed by Mr. Shkreli (the "MSMB Entities"), or that otherwise had financial dealings with Mr. Shkreli. The agreements provided for the issuance of a total of 612,500 shares of common stock of the Company, and a total of $400,000 in cash payments by the Company. The Oversight Committee concluded that the Company should not continue to treat these agreements as consulting agreements because their predominant purpose appears to have been to settle and release claims against the MSMB Entities or Mr. Shkreli personally, and not to provide meaningful and sustained consulting services to the Company.

In the second quarter of 2013, the company also entered into settlement agreements totaling $2.2 million in cash and more than 130,000 additional Retrophin shares:

As previously disclosed, in the second quarter of 2013 the Company entered into a series of settlement agreements with individuals or entities that had been investors in the MSMB Entities, pursuant to which the Company paid approximately $2.2 million in cash and issued 11,000 shares of common stock of the Company to such investors, and Mr. Shkreli delivered or caused to be delivered a total of 47,128 shares of common stock of the Company to one such investor. The Oversight Committee concluded that an additional previously disclosed settlement agreement entered into by the Company (and under which the Company paid $300,000 in cash) was also with a former investor in the MSMB Entities, and that the predominant purpose of this payment was to settle and release the investor's claims against the MSMB Entities and Mr. Shkreli personally. The Oversight Committee also concluded that Mr. Shkreli caused to be delivered an additional 80,000 shares of common stock of the Company to another former investor in the MSMB Entities pursuant to a previously undisclosed settlement agreement to which the Company was a party.

Paying the piperIn the view of the company, Shkreli was a "faithless servant" to it and it appears the feds agree. According to Bloomberg, in addition to treating Retrophin like a personal bank account, authorities say Shkreli used money from his former hedge fund investors to buy clothes, food, and pay medical expenses. Shkreli will now need to respond about those alleged schemes, as will his lawyer, Evan Greebel, who was also arrested today.

Todd Campbell has no position in any stocks mentioned. Todd owns E.B. Capital Markets, LLC. E.B. Capital's clients may have positions in the companies mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Todd has been helping buy side portfolio managers as an independent researcher for over a decade. In 2003, Todd founded E.B. Capital Markets, LLC, a research firm providing action oriented ideas to professional investors. Todd has provided insight to a variety of publications, including SmartMoney, Barron's, and CNN/fn.
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